Mom-pops play 'distressed' game

Very few benefit from autumn rally, survey shows

By

ThomCalandra

SAN FRANCISCO (CBS.MW) - Some 71 U.S. stocks have doubled or more in value in the past three months, rewarding small investors who have taken a lottery-ticket approach to the market.

Each of the handful of stocks have market values below $400 million and about half are considered "distressed" securities - penny stocks that were trading for a dollar or two, a CBS.MarketWatch.com share review shows.

The findings reveal a dark side to the autumn rally. Just 39 stocks with market capitalizations above $250 million have gained 40 percent or more in the past three months. That suggests a scattering of individuals and aggressive hedge funds are winning their lottery bets on small stocks while the vast majority of Americans continue to hold portfolios stained in red ink.

Large investors, such as mutual funds, trusts and $1 billion-plus hedge funds, rarely buy stocks with market values below $500 million. There are approximately 7,000-plus U.S. stocks with a total worth of about $14 trillion according to TrimTabs, a market research firm.

America's largest stocks have made small gains since the Sept. 11 terrorist attacks and are in the red for the past three months. Major stock indexes are about where they were on Sept. 10, the day before the terrorists wreaked havoc with the nation's economy. The exception is the technology-heavy Nasdaq 100 Index and its counterpart, the so-called QQQs, both up about 8 percent since Sept. 10 yet still below their levels of three months ago.

The mom-and-pop rally - and Tuesday's expected lowering of interest rates -- may not be enough to extend the autumn rebound.

The market "is driven up by index-basket players and computerized trading, which fishes for (price) stops, both computerized and mental," says Pravin Banker of LDC Bond Watch in Greenwich, Conn. "Real conviction is absent."

Indeed, the Nasdaq 100 Index Tracking Stock averages about $2.8 billion worth of trades each day and some days far more. On Oct. 17, some $4.6 billion worth of the QQQs, nicknamed Cubes, changed hands on the American Stock Exchange. Part of the volume may be linked to short-sellers who anticipate a sharp decline in the tracking security later this year.

The Cubes, which represent Nasdaq's largest companies, will get an overhaul in December, when approximately 16 stocks will leave the index for new names. The departing companies are all tech companies whose shares have been ravaged in the past year. The new names are mostly drug and health-care companies that are enjoying sharp market gains in recent months.

As for the small-cap gainers in the past three months, many were in health care and biotechnology, such as vaccine tester BioReliance Corp.
BREL
and identification company Visionics Corp.
VSNX
Visionics shares have gained more than 160 percent since Aug. 6 after the New Jersey company's face-recognition systems got publicity in the wake of the terrorist attacks.

Not all of the small-stock gainers are beneficiaries of the terrorism scare.

A river runs through it

Two of the largest gainers, Digital River
DRIV
and SportsLine.com
SPLN, -97.00%
owe most of their revenue to Internet delivery of content or software.

Digital River and SportsLine.com were two of the three stock choices made in this StockWatch column in late July. (See the Thom Calandra's StockWatch column.) Digital River, a Minneapolis provider of Web-based commerce services, is benefiting from an acquisitive chief executive, Joel Ronning. The shares have gained 180 percent since Aug. 6. See more on Digital River.

Digital River's story may be a model for investors willing to play the lottery-ticket game. In this case, Digital River's drive toward consistent quarterly profits comes at Ronning's determined hands. A former direct-sales executive, Ronning says he'll be darned if a larger Internet company scoops his operation up for the pennies it was trading for this summer.

Digital River's success, with a market cap ballooning to $340 million from $120 million in several months, may bode well for other Internet companies that deliver software applications or commerce engines. One such company, tiny Intraware
ITRA
is narrowing operating losses substantially, Chief Executive Peter Jackson says.

Intraware's current quarter ends Nov. 30. The California company could achieve yearly sales of $50 million or more, with February being a cash-flow positive date. Yet Intraware's stock at 65 cents or so gives the company a market capitalization of less than $20 million.

Insiders are worth following, too. The chief executive of money-losing SportsLine.com, Michael Levy, bought 275,000 shares of his company when the stock was in the $1 to $1.40 range in mid-August. Shares of the sports news and data publisher now sell for $3.20, with a three-month gain of 150 percent.

Still, mom-pop investors are trying to make up for more than a year of sharp small-cap and mutual fund losses. In that regard, they are seen as desperate yet still willing to throw darts at the wall.

Some small investors have stopped playing the game altogether. "You can only whistle through the graveyard for so long," says Mark Petralia from Decatur, Ga.

Even after a 4 percent average gain for domestic mutual funds in October, as of Monday, more than 90 percent of them were still under water this year, according to analyst Lipper Inc. U.S. domestic equity funds are down an average of 16.73 percent since the beginning of the year, Lipper says.

"One begins to wonder how much longer the common American citizen can believe what they are being told by our financial community before they have been picked clean of their wealth and assets," says Kevin Barry, another individual investor in Indianapolis.

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